Everything You Need To Know About Loans for Rental Properties

Purchasing a rental property can be a great way to generate passive income and build long-term wealth However, most real estate investors need financing to acquire investment properties That’s where rental property loans come in.

In this comprehensive guide, we’ll walk through all the ins and outs of getting a loan for a rental property. Whether you’re just starting out or are a seasoned landlord, understanding financing options is key to growing your portfolio.

What is a Rental Property Loan?

A rental property loan is simply a mortgage loan used specifically to purchase real estate that will be rented out to tenants. The property can be a single-family home, duplex, triplex, fourplex, or small apartment building.

Unlike loans for a primary residence, rental property loans typically have stricter requirements since they are seen as higher-risk for lenders. But they can be obtained from banks, credit unions, mortgage lenders, or private money sources.

Types of Rental Property Loans

There are several loan programs available for financing investment properties

• Conventional loans – Standard mortgages from banks/lenders conforming to Fannie Mae and Freddie Mac guidelines. Typically require 20-25% down and solid credit.

• FHA loans – Allow 3.5% down payment on 2-4 unit properties if living in one unit. Government-insured.

• VA loans – Offer 100% financing for eligible military buyers on 1-4 unit properties.

• USDA loans – Provide 100% financing for properties in designated rural areas.

• Portfolio loans – Non-conforming mortgages held by private lenders rather than sold to the secondary market.

• Blanket loans – Single loan to finance multiple rental properties. Requires 25-30% down.

• Hard money loans – Short-term loans from private investors/lenders, usually for fix-and-flip properties. Higher rates/fees.

• Private loans – Loans from individuals rather than institutions. Rates/terms tailored to deal specifics.

• Seller financing – The seller carries back part of the financing at purchase.

• Home equity loan – A 2nd mortgage on your current home used for a rental property down payment.

• Cash-out refinance – Taking cash from an existing home’s equity via a refi to buy an investment property.

Loan Requirements for Rental Properties

Lenders have stricter requirements for rental property loans compared to primary residence loans. Here are some common requirements:

• Higher downpayment – Typically 20-25% minimum. Conventional loans don’t allow down payment gifts.

• Better credit – Minimum 620 credit score, but many lenders want 700+ for the best rates/terms.

• More reserves – Lenders want to see 6-12 months of mortgage payments in reserves.

• Lower DTI – Your total debt-to-income ratio should be below 45% in most cases.

• Property management experience – First-time landlords may have a tougher time qualifying.

• 1-4 unit limit – Most conventional programs limit financing to small residential properties, not large apartment buildings.

• Occupancy requirements – FHA and VA loans require living in one unit for at least 12 months.

Always discuss specific requirements with multiple lenders before applying. Guidelines can vary.

How to Get Approved for a Rental Property Loan

Follow these tips to boost your chances of getting approved for a rental mortgage:

• Shop lenders – Compare offers from banks, credit unions, mortgage brokers, private lenders, etc. Rates, fees and requirements will vary.

• Review credit reports – Make sure your credit scores meet minimum requirements. Dispute any errors.

• Lower debt – Pay down revolving balances to reduce your DTI.

• Boost income – Show stablesource of income from employment, self-employment, or existing rentals.

• Grow reserves – Have 6-12 months of reserves in your bank account. 401(k) funds may also qualify.

• Gather paperwork – Have tax returns, W-2s, paystubs, bank statements ready.

• Run property numbers – Make sure the property cash flows with conservative projections.

• Hire a good agent – They can help you find and negotiate good deals.

• Consider owner financing – If you can’t qualify for a traditional loan, try seller financing.

The stronger your financial profile, the better mortgage terms you can get.

What Affects Rental Property Loan Rates & Costs?

Many factors determine what interest rate and fees you’ll pay when financing an investment property:

• Credit score – The higher your score, the lower your rate. 700+ scores get the best pricing.

• Down payment – 20-25% down gives better rates. Less than 20% down leads to higher rates.

• Loan type – Government loans like FHA/VA may offer better rates than conventional loans.

• Property type – Financing for multifamily properties is viewed as higher risk than single-family homes.

• Your debt-to-income ratio – DTI above 45% will result in higher rates or denial.

• Reserves – More reserves mean better rates. At least 6 months’ worth is recommended.

• Loan size – Loans over conventional conforming limits may have higher rates.

• Lender – Compare multiple lender quotes. Discount points can also buy down rates.

Shopping around and improving your financial profile are key to getting the lowest rate.

Tips for Getting the Best Rental Property Loan

Follow these tips when shopping for financing:

• Get pre-approved by multiple lenders to compare rates/fees.

• Ask about “limited cash-out” refinancing if you have an existing rental.

• Look for lenders that specialize in investment properties.

• Scope out local credit unions for potentially lower rates.

• Consider owner financing from motivated sellers.

• Ask sellers about assuming existing lower fixed-rate loans.

• Buy discount points to lower rates if you plan to hold long term.

• Look into blanket loans if financing multiple properties.

• Be open to adjustable-rate mortgages when rates are rising.

• Discuss using a HELOC versus large down payment.

Finding the optimal loan often requires creativity and an openness to exploring lesser-known options.

Pros and Cons of Rental Property Loans

Pros:

• Allow you to purchase the property even if you don’t have cash
• Interest expense and property depreciation provide tax deductions
• Potential appreciation to build long-term wealth
• Ability to scale your portfolio faster than saving up down payments

Cons:

• Monthly mortgage payments reduce cash flow
• Loan origination fees and closing costs
• Interest rates usually higher than primary home loans
• Need to qualify based on property’s projected rents and expenses
• Can lose property if unable to make payments

For most real estate investors, the ability to leverage financing to grow your number of units outweighs the drawbacks. But risks still need to be managed.

Alternatives to Rental Property Loans

If you don’t want the ongoing burden of a mortgage, here are a few options to consider:

• Pay all cash – The simplest route when possible. Avoid loans entirely.

• Use a HELOC – Tap available equity in your primary residence.

• Partner with others – Pool money with other investors.

• Crowdfund – Raise private money from crowdsourcing platforms.

• Lease-option – Lease then purchase from the seller over time.

• Wholesaling – Assign contracts on discounted properties for a fee.

• House hacking – Live in a multifamily property while renting other units.

• Hard money loans – OK for short-term projects but costs are high.

• Seller financing – Have the seller finance the purchase over time.

These alternatives can be great options, but leverage from rental property loans remains the most common way investors finance real estate.

Key Takeaways

• Rental property loans from banks and mortgage lenders allow investors to maximize leverage.

• Requirements like down payments and credit scores are higher than primary residence loans.

• Interest rates are usually 0.5 to 0.75% higher than owner-occupant loans.

• Shop multiple lenders and review all your financing options before applying.

• Improving your credit and financial profile can help you get approved and get the best deal.

While obtaining financing for investment properties requires some extra hoop-jumping, rental property loans remain an essential tool for buy-and-hold real estate investors.